Loblaw soars on plan to create one of Canada’s largest REITs

Loblaw Companies up on plan to create one of Canada’s largest REITs

TORONTO — Loblaw Cos. Inc. began to look a lot more attractive to beleaguered investors on Thursday when Canada’s biggest grocery chain made a move to create one of the country’s biggest real estate investment trusts.

Loblaw’s shares hit their highest level in more than two years after the company said it intends to create a real estate investment trust for the bulk of its vast property holdings: 35 million square feet with a current value of more than $7 billion. The stock closed at $38.20, up almost 14% with more than 17 million shares trading hands, far above its daily average.

As we looked over the circumstances of the last six to eight months, we felt it was the right thing to do

The news comes as the retailer has been racing to shore up its performance in advance of U.S. mass merchant Target’s foray into Canada this coming March and as rival Walmart dramatically boosts its grocery space.

Related

While Loblaw has been entering the final and most difficult phase of its sweeping IT overhaul, same-store sales in its retail operations, a key measure of performance, fell 0.2% in the 40-week period ending Oct. 8. The company said prior to Thuesday’s announcement that earnings will not grow significantly in the coming year because of the competitive onslaught.

“As we looked over the circumstances of the last six to eight months, we felt it was the right thing to do,” Galen Weston, Loblaw’s executive chairman, told a conference call with analysts.

Creating the REIT will build value for both Loblaw and the REIT, and increase Loblaw’s financial capacity to pay down debt, buy back shares and, Mr. Weston said, give it “long-term access to funds to put against growth.”

We expect distributions and interest payments made by the REIT to Loblaw will reduce the drag on earnings substantially

Loblaw expects to sell units of the trust through an initial public offering likely to happen in mid-2013. Loblaw will retain a majority interest of more than 80% of the REIT, executives said. Details on pricing and the number of units to be offered were not disclosed.

Chief financial officer Sarah Davis said the transaction will have a minimal impact on the retailer’s profitabilty in the near term. “Paying rent will reduce Loblaw retail EBITDA margins but we expect distributions and interest payments made by the REIT to Loblaw will reduce the drag on earnings substantially,” Ms. Davis said.

Loblaw’s real estate portfolio is 47-million square feet with an estimated market value of $9-billion to $10-billion, executives said. It owns 70% of its retail footprint in Canada and leases about 30% from other landlords. Loblaw will enter into long-term lease arrangements with its REIT on the properties it includes in the structure.

Asked whether the move was opportunistic given the robust REIT market this year or about getting cash, Mr. Weston said, “I think it was a little bit of both — we obviously believe we have an enormous amount of value in our real estate portfolio.”

Mr. Weston said the idea of creating a REIT to monetize the value of its assets had long been pitched by advisors and investment banks. Robert Waxman, now a portfolio manager with Silvercove Fund Management, said he can remember it being part of the discussion when he was real estate analyst a decade ago at Merrill Lynch. “Even back then we bantered this around,” he said. “Everybody has known the opportunity was there.”

Loblaw’s announcement comes a day after a consortium led by Canada’s KingSett Capital offered about $2.6-billion to acquire Primaris Retail REIT to add to its portfolio of Canadian shopping malls.

“The retail real estate market in Canada is incredibly hot and the prospects of unlocking that in a way that expands your income-producing capabilities has to be very attractive to everybody who owns real estate,” said Lisa Borsook, retail and commercial real estate expert at Toronto law firm WeirFoulds. “It makes a lot of sense.”

As a stand-alone entity, Loblaw said the REIT will benefit from a lower cost of capital to support its development and expansion. The company will also be competing with some of its biggest landlords, as it grows and adds new non-Loblaw properties and seeks out land beyond its own footprint.

Loblaw’s move is not unprecedented in the retail sector. Stellarton, N.S.-based Empire Co. Ltd., which owns the Sobey’s chain of grocery stores, spun out its real estate into a trust in 2006 and continues to hold a 46.5% ownership stake in Crombie REIT. That fact has not stopped Sobey’s from doing businesses with other REITs.

Loblaw is the sixth-largest tenant of RioCan REIT, the retailer’s biggest landlord.

“We are not concerned that [Loblaw] won’t do any more business with us, because if we have the right location, they are going to want to do business there,” said Fred Waks, chief operating officer of RioCan, adding his company will be open to entering joint ventures with Loblaw’s REIT.

Mr. Waxman said choosing to pull the trigger now probably came down to a cost of capital issue for the retailer. “You’ve got seven, eight, nine, 10 billion capital tied up in the retailer doing nothing,” he said, referring to the unrealized value of the real estate. “The incentive is to use that capital to grow to expand and invest in the operating business.”

The downside for Loblaw, he said, is that is will no longer have full control of its real estate even if it controls the REIT. “Now you have an independent management team, an independent board and they are going to make decisions on the real estate. That is why they probably have never done it before — because they always wanted control.”

The bulk of the REIT will be retail real estate, a mix across the country of stores and shopping centres, Mr. Weston said. Warehouses and office buildings will make up about 10% to 15% of the overall portfolio.

Creating the REIT will not affect the company’s overall expansion plans over the next five years, Mr. Weston said.

“But we definitely believe that it is going to allow us to accelerate real estate site development in core markets — in areas where we think we should develop our site density more quickly.”

Retailers are hardly alone in trying to realize the value of their real estate. Most of the banks have long sold off their real estate and Bank of Nova Scotia was the last major bank to unload its head office, selling it for $1.27-billion in May.

While the retailer said it intended to operate the REIT to have a steady long-term source of income from its properties and develop new ones, John Andrew, a professor of urban and regional planning at Queen’s University, suggested Loblaw might consider disposing of some of the pricier real estate assets over the long term.

“It is rare that you get a retail portfolio this size with this much value,” he said.

“They could take a page from what the banks have done, and lump some of these assets on to the market while the values are very high. I think we are going to see a lot more of these announcements in the first quarter of 2013.”

Canadian Tire has an enormous quantity of real estate assets — why would they not spin those off in a REIT?”

After Loblaw, few retailers have a sizeable enough real estate portfolio to spin into a REIT, said Michael Smith, an analyst with Macquarie Equities Research. Canadian Tire Corp. and Hudson’s Bay Co. both have sizable real estate portfolios, he said. Having just completed an initial public offering, investors would likely want to see how HBC performs before they sign on to a REIT in which the department store was the major tenant.

Active Investor was produced by Postmedia's advertising department in collaboration with iShares by BlackRock to promote awareness of this topic for commercial purposes. Postmedia's editorial departments had no involvement in the creation of this content.

Almost Done!

Postmedia wants to improve your reading experience as well as share the best deals and promotions from our advertisers with you. The information below will be used to optimize the content and make ads across the network more relevant to you. You can always change the information you share with us by editing your profile.

By clicking "Create Account", I hearby grant permission to Postmedia to use my account information to create my account.

I also accept and agree to be bound by Postmedia's Terms and Conditions with respect to my use of the Site and I have read and understand Postmedia's Privacy Statement. I consent to the collection, use, maintenance, and disclosure of my information in accordance with the Postmedia's Privacy Policy.

Postmedia wants to improve your reading experience as well as share the best deals and promotions from our advertisers with you. The information below will be used to optimize the content and make ads across the network more relevant to you. You can always change the information you share with us by editing your profile.

By clicking "Create Account", I hearby grant permission to Postmedia to use my account information to create my account.

I also accept and agree to be bound by Postmedia's Terms and Conditions with respect to my use of the Site and I have read and understand Postmedia's Privacy Statement. I consent to the collection, use, maintenance, and disclosure of my information in accordance with the Postmedia's Privacy Policy.